Original questions written against the published FINRA and NASAA exam content outlines — not actual exam questions. Every choice is explained.
Most futures positions held by financial rather than commercial participants are terminated by
- A.taking or making delivery of the underlying at the stated delivery date.Wrong. Delivery is available and anchors the market, but very few financial positions ever reach it.
- B.exercising the contract, in the way the holder of an option would.Wrong. A futures contract confers no election, since both parties are already obligated.
- C.allowing it to expire worthless once the price has moved against the holder.Wrong. No premium was paid to open the position, so there is nothing that can expire worthless.
- D.entering an equal and opposite contract before the delivery period begins.Correct. Offsetting extinguishes the obligation, which is how nearly all financial positions are closed.
Why: A futures contract creates an obligation on both sides, but that obligation can be extinguished by entering an equal and opposite contract in the same delivery month, which is what the great majority of financial participants do. Physical delivery remains available and is what anchors the contract to the underlying market, but a financial investor has no use for a warehouse of the commodity and closes out instead. There is no exercise decision, because neither party holds an election. Nor can the position expire worthless, since no premium was paid to open it.
A producer sells futures contracts to fix the price of a commodity she will deliver in six months. If the spot price rises sharply before delivery, she will
- A.receive the higher spot price, because a hedge protects only against a decline.Wrong. A short futures hedge fixes the price in both directions rather than in one.
- B.realise a loss on the futures that offsets the higher price her output now fetches.Correct. The two legs move against each other, which is precisely how the locked-in price is delivered.
- C.be released from the futures contract, the hedge no longer being needed.Wrong. A futures contract provides no escape when the market moves in an unwelcome direction.
- D.receive the higher price and keep a gain on the futures position as well.Wrong. A short position loses as prices rise, so it cannot gain on both sides at once.
Why: A futures hedge fixes a price rather than protecting one side of it, so the hedger gives up favourable moves along with adverse ones. Selling futures means the producer profits if prices fall and loses on the futures if prices rise, and that loss is offset by the higher price her physical output now commands. The net result in either direction is close to the price she locked in, which is exactly what she wanted when she hedged. An option would have preserved the upside, but only in exchange for a premium the futures contract does not require.
A client deposits initial margin to open a long futures position. If the market moves sharply against her, the maximum amount she can lose is
- A.the initial margin, which functions much like the premium on a purchased option.Wrong. Margin secures an obligation rather than purchasing a right, so it caps nothing.
- B.the initial margin plus whatever maintenance margin the exchange requires.Wrong. Maintenance margin is the level that triggers a call, not a ceiling on the total loss.
- C.not limited to the deposit, since she remains liable for the full loss on the contract.Correct. The obligation runs on the notional amount, and the deposit merely secures it.
- D.the notional value of the contract, which the exchange collects at the outset.Wrong. Nothing close to notional value is collected up front, which is precisely what creates the leverage.
Why: Initial margin on a futures contract is a good-faith deposit securing performance of an obligation, not the price of the position, and it does not cap the loss. The holder is liable for the full adverse move on the notional amount of the contract, which is settled daily through variation margin and can exceed the original deposit many times over in a fast market. That open-ended exposure is the single most important difference between a futures position and a long option, where the premium paid is the entire risk. It is also why futures accounts carry their own disclosure and approval requirements.